The first, and perhaps most important, revenue source we should augment is property taxes, whose current contribution to public revenues is negligible. In 2016, India’s ratio of property tax to GDP was 0.07 per cent. In contrast, France and the UK generated nearly fifty times more, with ratios of 3.56 and 3.29 per cent respectively. Even among middle-income countries, property tax revenues are around twenty times higher in China (1.53 per cent), South Africa (1.33 per cent) and Brazil (1.47 per cent).

Public welfare will be substantially improved if Indian cities can raise more revenue from property taxes. This aligns with several principles. First, property is not mobile, making taxes easier to collect. Second, property taxes are controlled by local bodies and fund local public services, such as water, sewage, and transit. This clear link between taxation and services provides property taxes more legitimacy than many other taxes. Third, when tax revenue is used to improve local infrastructure, it can boost property values. This can create a virtuous cycle between taxation, provision of public goods, property value appreciation from the higher quality of life from living in that area, and a further increase in tax revenues to provide even better public goods. Fourth, property taxes are highly progressive, since the poor typically do not own property.

Senior policymakers like Finance Secretary Dr TV Somanathan and former CEA Dr Arvind Subramanian have endorsed the importance of property taxes, noting in 2014 that “few taxes are as compelling”. Yet, a decade later, not much has changed. One reason is that state governments have not invested in building the capacity of urban local bodies to assess and collect property taxes. Areas of underinvestment include satellite mapping; cadastral surveys of land use and property boundaries; updated databases of property, ownership, titles, and liens; and automated systems for generating property tax invoices and following up on non-payment. One reason state governments have not prioritized property taxes is that they accrue to local bodies and not to them.

However, this neglect is short-sighted. Urbanisation drives economic growth, and the resulting increase in economic activity will raise state government revenues through higher GST proceeds. So, boosting urbanization is good for states. But, urban growth is constrained by weak urban amenities, which are constrained by low revenues. To break out of this vicious cycle, state governments should invest in the capacity of local bodies to generate more property tax revenue, and make it a top priority.

Increase taxes on private transport in urban areas to finance better public transit

A second underused urban revenue source is higher charges for private transport. This can be done through a combination of higher road taxes, registration fees, parking fees, fossil fuel taxes, and congestion charges. These measures not only raise revenue but also increase economic efficiency and population well-being because the current price of private transport overlooks its true social cost. Even excluding climate change costs, private transportation is underpriced due to the health and congestion costs imposed on others. Estimates suggest that urban pollution in India may be responsible for a loss of 650 million years of life. Similarly, a recent NITI Aayog report estimates that traffic congestion in just the four largest Indian cities costs over Rs 1,50,000 crore each year from lower productivity, fuel waste, and accidents.

So, higher carbon taxes and electronic road pricing will not only raise revenues but also improve social welfare by raising prices on activities with negative externalities. Parking fees should be higher and reflect the scarcity and value of urban land. The political costs of these taxes and fees should be managed by earmarking this revenue for investments in urban public transport and communicating the public interest rationale for such policies. This is the approach followed successfully by Singapore where high taxes and fees on private transport (including on cars, roads, and fuel) are combined with investments in and subsidies for socially efficient public transport.

For fossil fuels such as petrol and diesel, states should impose a cyclically adjusted tax that rises predictably over time. This tax would decrease when global oil prices rise and increase when they go down. The average tax rate and target price should rise steadily over time (say 2 per cent annually). Such an approach would (a) provide a steadily growing stream of “efficient” revenue by taxing a commodity with negative pollution and congestion externalities, (b) cushion consumers from price volatility by aligning taxes inversely with global oil prices, and (c) allow firms and consumers to plan production and purchases of vehicles based on anticipating steady fuel price increases.

Again, earmarking these taxes and fees for visible investments in urban public transport can make them politically palatable and encourage a shift from private transport towards more energy and environmentally-efficient high-density public transit. As a former mayor of Bogota, Enrique Penalosa has memorably noted: “An advanced city is not one where even the poor use cars, but rather one where even the rich use public transport.” India would do well to heed this message. The role model for India’s urban future should not be the US with lower population density and higher use of cars, but large European and East Asian cities with similarly high population densities, and high-quality public transit.

Bringing it together: Financing urban infrastructure and amenities

India requires an estimated Rs 3.5 lakh crore of investment in urban infrastructure and amenities every year over the next decade. However, we also face a large financing gap, which is limiting our ability to make these welfare-improving urban investments.

The principles in this section can help finance such investments. Consider a project like expanding a bus fleet or building a mass transit system. Based on the principles above, it should be financed using a combination of Central and state government funding, user charges, fossil fuel taxes, parking fees, and property taxes. Such a financing model reflects the distribution of benefits from the investment, and ensures that each contributing party is better off with the project than without.

Specifically, the project will (a) boost economic activity and yield higher GST revenue, justifying government funding; (b) benefit commuters by cutting private transport costs, justifying user charges; (c) facilitate switching from private to public transport, justifying higher fees on private transport to reduce congestion and pollution; and (d) raise property values near transit stops, justifying using some property tax revenues to fund it.

The key takeaway is that consumers, citizens, and property owners will all be better off after the project, even with user fees and property taxes, because the benefits will be higher than costs. However, if governments do not collect adequate user charges or property taxes, they may deem the project unaffordable and not undertake it. Thus, designing financing models that better align the benefits and costs of urban amenities can make it politically and economically viable to finance them.

Excerpted with permission from Accelerating India’s Development: A State-Led Roadmap for Effective Governance, Karthik Muralidharan, Penguin India